China Vs The Oil Market
How its latest fiscal stimulus announcement impacts the oil market.
The prevailing narrative in the oil market today is straightforward:
OPEC+ production increase (announced on Monday) will result in more surplus in the market and lower oil prices.
Trump's tariffs will result in slower economic growth and lower oil prices.
Weak US economic data will result in a recession and lower oil prices.
But for the oil bulls, it's not that straightforward. Here are the counter-arguments:
Non-OPEC supplies are stalling. By Q2/Q3 this year, non-OPEC supplies will show lower y-o-y figures.
China's fiscal stimulus announcement (last night) will push non-OECD demand higher.
Global oil inventories are failing to build in Q1. Physical oil market conditions are not showing material builds going forward.
OPEC+ supply increase is slow by design (+135k b/d per month).
But taking a step back, I think last night's China fiscal stimulus announcement altered the landscape of the commodity markets. I think now is a good time to revisit a WCTW piece we published on Dec 9, 2024, titled, "Moderately Loose? No, I'm Not Talking About The Oil Market. Buckle Up, It's About To Get Real."
Here's what we said:
In my view, most of the other statements are rhetoric (in reference to the monetary policy stance change to "moderately loose"), but the most important word here is "confidence", and I think that in itself is the seismic change we need to see. Now that he's put himself front and centered on the incoming Chinese stimulus policy, confidence is what he wants to see and confidence is what he will get.
Before we delve deeper into what changed, it's important to understand the importance of "face" in Chinese culture. When a Chinese leader announces that he will do something, especially in the case of Xi, who forced the Chinese communist party to adopt "Xi Jinping Thought" akin to Mao's thoughts. Failure is not an option.
And because failure is not an option, every setback in economic data will just imply even more stimulus ahead. It's a bit similar to the "Fed put" we saw back in 2010. If the data worsens, the Fed will stimulate more. If the data gets better, the Fed will stay on the sidelines. China won't be any different.
In particular, I've repeatedly pointed out that China's big problem today is credibility and this is echoed in the dismal business and consumer confidence. People do not believe that China has the guts or the willingness to revive the economy. Following the stupidity of zero COVID policy, people distrust the government, so it's no surprise that when I went back to Shanghai in October, people were despondent on the latest fiscal economic policies.
"Nothing's changed" was the tone I got, and I suspect it's still an uphill battle from here.
But if Xi wants confidence, he will get confidence. Given how low bond yields are and how low inflation is today, China can stimulate without worrying about inflation skyrocketing back. I suspect it will find itself in the same predicament as the US post the Great Financial Crisis. Despite 3 iterations of QE infinity, inflation never came back, and China is likely in the same situation.
Fast forwarding to today and with Trump's trade wars in full effect, China is starting to take its fiscal stimulus seriously. Following the comments in December about altering its monetary policy to moderately loose, China's fiscal stimulus announcements last night further validated that they are indeed serious.
Here are the NPC 2025 targets:
GDP growth target of ~5%.
Budget deficit of ~4% (the highest in over 30-years).
4.4 trillion yuan of new special local government bonds.
500 billion yuan in special sovereign bonds for bank recapitalization.
China is also targeting ~2% inflation, which is the first time in over 20 years. It is an acknowledgment (finally) that China is going through deflation.
Similar to what we have been saying about China for the past 6-months, this fiscal policy is a reactionary policy to the recent Chinese economic data that has been released. And if last night's policy response still shows muted economic growth, then more fiscal stimulus will be announced. Either way, you slice and dice this, if Xi wants higher growth, Xi will get higher growth.